LP Gas Industry SA Nov 07

Liquefied Petroleum GasIndustry Research Paper

2007

Gherda Stephens 11/24/2007

Liquefied Petroleum Gas (LPG) consists mainly of propane (C3H8 ) and butane (C4H10) and is primarily used for domestic and commercial applications (including as a vehicle fuel). LPG is kept liquid by confining it under high pressure

Liquefied Natural Gas (LNG) is liquid at atmospheric pressure but at a very low temperature (approx. –162 °C). Natural gas is lighter than air so that it rapidly disperses and becomes diluted in air, in contrast to the components of LPG which are heavier than air

TABLE OF CONTENTS

Executive SummarySummary of South Africa’s current & future energy issuesDevelopments in the Gas IndustryDevelopments in the Liquefied Petroleum Gas (LPG) Industry ConclusionOpportunities & Potential Benefits for a bank as investor and/or financier

1. LPG: Structure and Analysis of the Industry

1.1 Traditional Structure1.2 Delivery chain1.3 End-users

2. LPG Regulation

2.1 The context for energy policy

3. LPG Supply and Demand

4. LPG Pricing

5. Opportunities in the LPG Industry

6. Annexures

DOCUMENT ANNEXURE

White Paper on the Energy Policy of the Republic of South Africa (Dec 1998)A

Energy Master Plan B

Energy Infrastructure Plan C

Southern Stream Energy Resources (Pty) Ltd – Business Plan 2007D

APPROPRIATE REGULATORY FRAMEWORK TO FACILITATE ENTRY OF PIPED GAS INTO THE MARKET E

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Executive Summary

Sustainable energy supply and global warming are two controversial issues that enjoy top priority status by most governments worldwide. Locally, government and industry specialists recommend gas as one of the most efficient and cost effective alternative and supplement for electricity as scarce energy source and also as alternative feedstock to coal to reduce carbon emissions.

Significant developments are taking place in the South African Gas Industry at the moment and this paper identifies the possible future leaders in the niche Liquefied Petroleum Gas (LPG) industry. It also highlights the need for substantial private investment in these companies and the necessity of having the backing of a reputable, financially strong “household name” as shareholder and/or financier. Finally, the report suggests that the decision by a bank to take a long term view on these companies in providing investment and/or funding at this crucial stage, may result in substantial benefits, both financially and strategically for this bank in the future. The potential benefits, are listed on page 5 below.

In order to have an in depth understanding of the future of LPGas in South Africa, one first has to investigate & understand all the strategic issues that influence the current & future energy scene.

Summary of South Africa’s current & future energy issues:

1 During May 2007, the National Energy Regulator of South Africa (Nersa) released an audit report conducted in 11 electricity distribution utilities in the country. The report showed that the distribution industry's operations are sub-optimal with an infrastructure maintenance backlog of approximately R7 billion. This scenario poses a serious challenge for the restructuring of the electricity industry in the country and calls for the acceleration of the Electricity Distribution Industry (EDI) restructuring process. (Budget Vote Speech, Minister Buyelwa Sonjica of the Department of Minerals and Energy (DME) on 07June 2007)

2 Government (DME) is reworking a National Electricity Master Plan in collaboration with Water affairs & forestry, Public Enterprises and Trade & industry that is expected to be finalised and approved during 2008. The pillars of the master plan would include increasing capacity, providing reasonably priced electricity and insuring security of supply as set out in the standards. This emerged at a briefing on 22 November 2007 by government spokesperson Themba Maseko who said: “The investment in maintenance and rehabilitation of infrastructure and the quality of supply of electricity will be regulated in future” (Business Report 23 November 2007).

3 Capacity challenges that have manifested themselves in frequent Electricity blackouts and fuel shortages are consequences of infrastructure constraints as well as the inadequacy of some of the demand and supply plans that were put in place years ago.

4 The extent to which government has committed to the promotion of access to affordable and sustainable basic energy services, is contained in the 1998 “Energy White Paper” (Annexure A) policy statement: “It will be the government‘s commitment to promote access to affordable and sustainable energy services for small businesses, disadvantaged households, small farms, schools, clinics, and other establishments in our rural and other communities”

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5 The Department of Minerals & Energy (DME) has developed an “Energy Master Plan” (Annexure B) which incorporates a detailed “Energy Infrastructure Plan” covering the next five years to address these challenges.

6 The DME will be presenting the Electricity Distribution Industry (EDI) Restructuring Bill to Parliament before the end of 2007. This will be in line with the Cabinet decision of 25 October 2006 in terms of which the EDI will be restructured into six wall to wall REDs as public entities managed through the Public Finance Management Act and regulated by Nersa.

7 Within the implementation of the Integrated National Electrification Program (INEP) a program implemented to provide basic energy to vulnerable groups, the absence of bulk infrastructure, especially in rural areas has put a strain on the performance of the program. With sufficient budget approved going forward, (R2.96 billion for 2007/2008) the DME undertook to eradicate the backlog of all clinics by the end of this financial year and all schools within three years.

8 Climate change and the managing of greenhouse gas (carbon) emissions has gained unprecedented International exposure this year and environmental and tourism minister Marthinus van Schalkwyk said there would be a stricter regulatory framework and a hefty price on carbon in the future. “Government will increasingly assess, monitor and regulate greenhouse gas emissions” he warned. The Carbon Disclosure Project (CDP), SA’s first attempt to understand how top local companies are responding to climate change, found that SA’s top companies are failing to translate the effect of climate change into action. (Business Report, 23 November 2007).

9 Government has set a target of having 25% BEE ownership in the petroleum industry and the DME has made it clear that all future business and joint ventures will be with BEE compliant companies only.

Developments in the Gas Industry

Government's gripe is that the industry is dominated by a few big players, and it is difficult for smaller operators to break into. All future projects will be BEE driven.

The Government’s stated policy is to develop the natural gas industry, to legislate for the storage, transmission, distribution and trading of piped gas, and to develop a minimal regulatory regime ‘consistent with the orderly development of a competitive gas industry’. (APPROPRIATE

REGULATORY FRAMEWORK TO FACILITATE ENTRY OF PIPED GAS INTO THE MARKET – ANNEXURE E)

A huge increase in the availability of the environmental friendly gas, Liquefied Natural Gas (LNG), occurred earlier this year as a result of the newly established Mozambique LNG Pipe Line. (Detail in Gas Infrastructure Plan – Annexure C) The pipeline only serves a certain area (Durban, via Nelspruit & JHB to SAPREF in Kimberley) and the possibility to expand this pipeline inland and to the rural areas still proves to be unviable due to the high cost of establishing a new pipeline.

This cheaper and more readily available gas is ideally suited for heavy commercial and industrial activities and users in these segments account for +-75 % of the total gas consumption in SA. The remaining +-25% users are mainly households where the (currently) more expensive LPGas is the suitable choice. (more about this below).

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The DME will in the near future pass legislation approving the issuing of licences to bulk users of gas which will enable them to buy natural gas directly from the refineries. Bulk users of gas include companies like Highveld Steel, Coegga, Iscor, Eskom etc.

Developments in the Liquefied Petroleum Gas (LPG) Industry

In November 2005, the Liquefied Petroleum Gas Safety Association of SouthernAfrica established a BEE Division, as part of the Association. The aim of this division was to facilitate entrance, participation and empowerment of BEE companies in the LPGas industry. The Forum started with a membership of twelve BEE companies.

Challenges• The challenges faced by BEE companies are the ability to import, store and distribute

LPGas. Most BEE companies in this industry are either installers or small distributors with no containers or distribution channels of their own. They are totally dependent on the big four - BP, Easigas, Afrox and Totalgaz for their LPGas.

• Lack of regulation of LPGas, according to the Mail & Guardian of 2 June 2006 resulted in a significant increase in the price of the product.

• The capacitating of emerging BEE companies through training and access to funds would play a role in achieving the government’s target of 25% ownership of BEE in the petroleum sector.

Opportunities: 2007 and beyondTransformation/change in the petroleum, oil and gas industry is formulated in the Petroleum Charter of the Department of Minerals and Energy (DME). This is, however, a tricky process and the government, industry and business have a vital role to play in embracing and facilitating the much needed change in the LPGas industry. In the past in South Africa ‘energy’ has been equated with electricity and more attention has been given to access to electricity as opposed to ‘… providing access to safe, affordable, appropriate and modern energy for the people of South Africa…’ - the mandate of the DME, as expressed in the White Paper for Energy of South Africa, 1998.

In recent years, there have been important changes in government policy towards a more balanced energy provision to include cleaner, safer, affordable energy for all, particularly focusing on the residential markets and low income earners.The BEE and the Petroleum Charter provide a basis for change in access to resources and participation by BEE companies in the LPGas industry.

In her 2007 Budget Speech, the minister of Minerals & Energy (Buyelwa Sonjica) made the following statement: “A challenge which continues to confront us is that most of our people especially the vulnerable groups have limited access to energy to meet their thermal needs. Even when they have electricity, they continue to use low-grade coal and paraffin for heating and cooking. In studying ways to uplift the vulnerable groups through efficient energy resources, we have launched a pilot project in partnership with municipalities in Tshwane and Tembisile to provide 30 000 households with modern thermal fuels, in the form of LP Gas (LPG).

This pilot is done by a private company called Southern Stream Energy Resources (Pty) Ltd (SSER) under the leadership of the industry’s well respected Kingsley Tloubala. (Refer to CV on p5 of SSER’s Business Plan, Attached as Annexure D). This project (and similar ones approved for other areas in SA, see point 5 below) is done on the basis that the DME provides funding (grants) for Capex (storage facilities, tanks, cylinders & household appliances - R22 mil in the initial Pilot) and SSER must provide funding for the operational, marketing and distribution

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expenses. The “spin-off” of these projects are that the households now need to re-fill the cylinders on an ongoing basis and legally, this can only be done by the owners of the cylinders who are the suppliers of the gas. SSER operate this spin-off in the name of a wholly owned subsidiary called ContiGas (Pty) Ltd (also their Brand name).

The purpose of the pilot project is to enable the DME to review the regulatory framework on two counts: (1) the promotion of a more energy efficient carrier like LP Gas as an electricity demand side management initiative and (2) for the development of an appropriate pricing mechanism for LPG.

The Government has over years made noises and tried to talk to the industry leaders (Afrox) about an appropriate market solution to the high LPG prices but it has remained unacceptably high. The recent shortages in the supply of CO² (and Coke) were one of the direct consequences of these hostile discussions between government and the private sector. In her budget speech the minister declared “We now have no choice but to regulate the LPG industry

SSER acts as adviser to the DME in establishing the proposed regulated LPG price, due to become in force during the first quarter of 2008. The DME’s target price is R7,50/Kg and Afrox is currently selling at R18,00/Kg

SSER is officially appointed by the DME to run similar projects in the Free State, Sol Plaatjies (Kimberley), Limpopo and Mpumalanga

Government has committed to convert 10 million households to LP Gas in the next 5 years and has allocated a budget of R485 mil (for Capex as described above) to achieve this.

LPG Safety Association of Southern Africa (LPGSASA) communications manager Kevin Robertson said. “There is a requirement for gas installers in all facets of the industry. “The growth of LPG in the domestic area, particularly in rural areas, will create many opportunities in the gas industry.“If people are moving away from electricity to an alternative fuel, the alternative fuel must be efficient, safe, and versatile.” Interestingly, international trends indicate that the fuel of choice for cooking is gas.“It’s clear that a move from electricity to LPG is a step forward rather than backward,” Robertson affirms. (Refer to Annexure E)

Conclusion

Heavy commercial and industrial business have started to use NG as their gas of choice and as clients in these segments continue to convert to NG, the demand for LPG is declining (refer to official statistics released by SAPIA - Sales of Major Petroleum Products in South Africa under 2.1 below)

The decision of 75% of the market to convert to Natural Gas, coupled with the forthcoming price regulation of LPG and the fact that soon, users of bulk gas will be able to buy gas directly from the refineries, are driving the traditional players in the LPG market (the 6 wholesalers listed below) out of the industry.

As official partner (100% BEE) to convert households to LPG in the majority of SA, SSER is busy establishing itself as the market leader in the consumer LPG market.

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The conversion of 10 million households to LP Gas will result in a monthly demand of at least 120 000 tons. This is three times that of the current availability (40 000 tons per month) and government is in the process of granting a license (the only 10 year concession available) to a BEE Consortium for the importation and storage of sufficient LPG supplies to meet the new increased demand. This equates to infrastructure development of hundreds of millions of Rands.

A BEE consortium called “Xxxxxxxxxxxx” is the favorite to obtain this license. The 2 major stakeholders will be Xxxxx Energy (a partnership between SSER & Xxxxxx Investments International (Pty) Ltd - 51%) and the Xxxxxx Group. (Exploration license for coal Bedded Methane; Koni Media, Johnnic Group). The strategic importance of these two stakeholders are vested in the strong financial position and the proven performance capabilities of the Xxxxxx Group on the one side, and the established successful working relationship between the shareholders of Xxxxxx and government/DME. The shareholders of Xxxxxx are Mr. Y, (advisor to the DME & major role player in alternative energy projects), Mr Z, (ANC Reg D/G/NEC), Mr. X, (ANC & ambassador) & Mr P (Apartheids era freedom fighter, ANC & ambassador. The Xxxxxx Group’s CEO is Dr S, (mastermind of the -------- deal). The other stakeholders will be -------------- (Pty) Ltd and Industry.

One of the existing LPG wholesalers is already in the market (unofficially). The asking price for their infrastructure will be in the region of R100 – R120 mil

Opportunities & Potential Benefits for a bank as investor and/or financier

(Notes in frames are extracts from X Bank’s Sustainability Report for 2007)

Become one of the first JSE Top40 Companies to take action for clean air as a committed Private Equity Stakeholder in the “new School” BEE Consortium (National Storage SPV/Consortium) to provide financial backing and credibility to this key role-player in the Liquefied Petroleum Gas (LPG) Industry.

WHY OUR INDIRECT ENVIRONMENT MATTERS TO USAs a provider of finance, we enable products and services to be accessed, and facilitate consumption. We therefore have a role to play in balancing the conflicting need to facilitate South Africa’s requirements for a growing and inclusive economy, with the need to ensure such growth is enabled in a responsible social and environmental manner. For us, this translates into both risk management and business opportunity development.

The distribution of LPG to households is done via mobile technology (ordering, pre-payment and confirmation of door-to-door delivery is done via cell phone technology which is part of the initial hand-out to the households). This will give X Bank access to between 30 000 (immediately) and eventually +- 6 mil previously “unbankable” customers.

Banking the Previously UnbankedWe continued to provide entry-level banking services through the Mzansi Account to ensure access and affordability to entry-level clients who previously did not have a bank account.Over the last year, we opened 369,506 accounts, up from 280,581 from the previous year. This indicates an increasing acceptance of formal banking by new entrants into the banking sector.

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Banker of Choice to the Consortium with opportunity to channel/facilitate the R485 mil budgeted spending on infrastructure (specifically for LPG) by the DME

R120 mil Leveraged Finance funding to acquire the business/infrastructure of one of the “old school” LPG wholesalers (BP Gas)

Other funding requirements to finance Capex and working capital. (Initially, and already in the pipeline Rxxxxxxx

Helping Start-Ups and Small BusinessesWe provide tailor-made solutions for start-ups with a trading history of less than two yearswith a one-stop shop offering to facilitate financing of transactions regarded as previouslyun-bankable focusing on all phases of the business life-cycle from idea and concept,mentorship through to investment products.

Funding will qualify as “BEE Funding” and will assist towards the Bank’s BEE funding targets.

Sustaining TransformationEnabling Black economic empowerment (BEE) is an integral part of our business strategy.We developed comprehensive solutions for BEE coinciding with the gazetting of the DTIBroad-Based Black Economic Empowerment Codes of Good Practice to assist businesses to transform in a sustainable manner. Our value proposition focuses on providing comprehensive solutions such as BEE rating of our clients, sourcing and procuring from BEE partners and suppliers and ongoing mentorship.We also provided funding to enable BEE ownership transactions. For the 2007 financial year to date, 30 transactions amounting to an aggregate disbursement of just over R250 million were financed to enable empowerment-related ownership buy-in transactions. In addition, we provided finance in 21 transactions to a total value of R43 million directly to existing black owned businesses.

LPG is a clean burning and does not pollute the air – X Bank will be associated with assisting to create a healthier environment.

The South African Government has introduced additional depreciation allowances for permanent structures, as outlined in the Minister of Finance's February 2000 budget speech, to encourage investment in strategic infrastructure projects: Dispensation under Section 12(c) can be granted to a third party such as a bank financing a power plant etc.

Gherda StephensClient Portfolio Executive (New Business)

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Wholesale (6)

Refineries (6)

Distributors

Dealers

End users

Retailers

RESEARCH PAPER

LPG (Liquid Petroleum Gas)

November 2007

1. Structure & Analysis of the Industry

1.1Traditional Structure

The South African LP Gas industry is vertically integrated by brand with most key players participating at all levels of the value chain raising barriers of entry into the industry. Refer to Figure 1 below: (Source: SSER’s Business Plan – attached as Annexure _____)

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Figure 1: Current SA LP Gas Industry Structure

1.2 Delivery Chain:

Liquefied Natural Gas (LNG) delivery chain comprise of the following elements:

•Transport of the gas from the wellhead to the liquefaction plant

•Purification and liquefaction by cooling the gas to -160oC.

•Storage at production site.

•Ocean transport of the LNG.

•Unloading and storage at the reception terminal

•Reception, storage and regasification.

The elongated value chain hinders progress in utilization of LP Gas in SA’s domestic sector due to complex and fragmented supply chains that leads to unduly high price build-up.

Table 1 shows SA refinery owners and their respective market share.REFINERIES

NameSapre

fGenref Calref Natref Sasol PetroSA

OwnersBP & Shell

Engen CaltexTotal & Sasol

Location Durban DurbanCape Town

Sasolburg

Secunda Mosselbay

Market shares

25% 13% 15% 28% 10% 10%

Table 3 shows the SA LP Gas distributors and their respective market share

DISTRIBUTORSName Shell Engen BP Total Afrox Other

Brand EasigasBP Gas

Totalgaz Handigas

Market share

19% 5% 27% 7% 41%

1.3 End Users

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Table 2 shows the SA LP Gas wholesalers and their respective market shares

WHOLESALERS

Name Shell Engen BPTotal

Afrox Other

Market share

19% 5% 27% 7% 41%

The communities / households Commercial clients like restaurants Industrial

2. LPG RegulationEnergy Policy White PaperThe South African White Paper on Energy Policy 1998 has described gas as an attractive option and states that the government is committed to the development of the gas industry.The White Paper outlined the following key energy policy objectives:

• Competition within and between energy carriers.• Increasing access to affordable energy services.• Improving energy governance.• Stimulating economic activity.• Managing energy-related environmental impacts.• Securing security of supply through diversity of supply.• Promoting NEPAD cross-border type projects.

The South African Government has set out the following objectives for the development of the gas industry:

• Ensure the provision of gas as soon as possible at the lowest possible price;• Ensure the establishment of the appropriate transmission infrastructure required for

industrial projects;• Promote orderly development, operation and provision of gas services, the key being

transmission infrastructure;• Ensure that the gas industry is safe, efficient, economic and environmentally responsible;• Ensure that gas services are provided in a non-discriminatory manner that meet the needs

of the customers;• Promote competitive markets by facilitating gas-on-gas competition through third party

access (TPA) to transmission pipelines; and• Facilitate the trade of gas between the South Africa and other countries through formal

agreements, gas transmission infrastructure development, and specific projects.

APPROPRIATE REGULATORY FRAMEWORK TO FACILITATE ENTRY OF PIPED GAS INTO THE MARKET (Petroleum, Coal and Gas Directorate)The Government is attempting to harmonise regional gas policies and establish bi-national agreements. Key policy challenges associated herewith are outlined in this document. Coal-bed methane (a natural gas) mining will be promoted from the exploration stage, through to production.

The Gas Act, 2001 (Act No 48 of 2001)The Gas Act promotes the orderly development of the South African piped gas industry.The Act envisages the granting of licenses for the construction, operation and trading for transmission, distribution, liquefaction, regasification and storage within a set framework of requirements and limitations. The Minister may promulgate regulation after consulting with the regulator and allowing for public comment.The objectives of the Act are to:

• Promote efficient, sustainable, and orderly development and operation of the• downstream gas industry;• Facilitate investment;• Ensure safe, efficient and environmentally responsible downstream gas industry;• Promote historically disadvantaged firms;• Ensure that gas services are equitable and that present and future needs are met;

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• Promote competitive markets;• Promote skills and employment equity; and• Facilitate gas trade between the RSA and other countries; and• Promote access to affordable and safe gas.

Section 36 of the Gas Act binds the Regulator to the Government/Sasol Agreement that pertains to the Mozambique/South Africa gas transmission pipeline and addresses derogations on the forth-coming gas regulations for a period of up to ten years, depending on the amount of gas reserves available.

The Gas RegulatorThe Gas Regulator, established in 2005 as part of a single Energy Regulator that regulate the electricity, piped gas and petroleum pipelines industries, and will serve as a custodian and enforcer of the national and regulatory framework.

The functions of the Gas Regulator are to:• Issue licenses• Gather information relating to the gas value chain• Undertake investigations and inquiries into the activities of licensees• Consult with government departments and other bodies and institutions regarding any

matter contemplated in the Act• Consult with government departments and gas regulatory authorities of other countries• Regulate prices;• Expropriate land;• Promote competition in the gas industry;• Promote optimal use of available gas resources;• Take decisions that are not at variance with published Government policy;• Publish from time to time a list of other legislation applicable to the gas industry;• Perform any activity incidental to the performance of its functions• Exercise any power or perform any duty conferred or imposed on it under any law

Summary of main deliverables since 1998:

Gas Act, 2001 (Act No. 48 of 2001) was promulgated in 2002 and operationalised in 2005.(note 4)

National Energy Regulator establishment on 1 October 2005. Gas Levies Act 2002 (Act No. of 2002) promulgated in 2002. South Africa/Mozambique cross border Agreement was negotiated and then signed in

2001. The SA/Mozambique Gas Commission was established on the 7th March 2002 to ensure that no bureaucratic interruptions occur. The South Africa/Mozambique pipelines was completed in March 2004, currently the pipeline capacity is around 90 MGJ/a, the pipeline will reach full capacity of 120 MGJ/a possibly in 2008.

South Africa/Namibia cross border Agreement was negotiated and then signed in 2001. The SA/Namibia Gas Commission was established in 2005 which is currently investigating a cross border- pipeline from Kudu Gas Field in Namibia to Western Cape in South Africa. Namibia is moving to commercialise the Kudu Gas Field

PetroSA is expanding its interests in gas locally and outside of South Africa [regionally in Mozambique; Nigeria, Gabon, Sudan, Equatorial Guinea, North Egypt, Libya, Morocco and Qatar]

LNG receiving terminals are being investigated at Coega and Saldanha Bay GTL Plant in Mossel Bay operated by PetroSA since 1992 and its gas feedstock supply

has been extended by a further four years in 2007. Piped Gas Regulations was promulgated and announced on 20 March 2007. Methane to Markets - following a preliminary investigation, RSA is in the process of

applying for Methane to Markets membership.

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The DME's plans to regulate the market may go further than the industry expects. "We will be examining the industry structure too," says Gumede, spokesperson for the DME. Government's gripe is that the industry is dominated by a few big players, and it is difficult for smaller operators to break into. "One constraint is the system around the usage of gas cylinders," he says, explaining that consumers cannot own their own cylinders as they belong to the wholesalers. A new industry entrant needs to own a critical mass of gas cylinders before the system becomes more competitive. "We envisage some concession areas," says Gumede.

3. LPG Supply & DemandThe entire gas and condensate output in SA is dedicated to PetroSA's liquid-fuel synthesis plant, and accounts for about 1,5 percent of total primary energy supply. Gas manufactured from coal accounted for 5 percent of net energy consumption, while LPG accounted for about 6 percent. (Department of Minerals and Energy Energy GAS.mht)

2.1 SAPIA - Sales of Major Petroleum Products in South AfricaLatest Quarter

Gas and welding company Afrox tells Engineering News¹ in an exclusive interview that the size of the liquid petroleum gas (LPG) market in South Africa is growing at between 8% and 12% a year. Afrox GM for LPG Kevin Munro says the industry is expected to continue to expand and has the potential of effectively doubling its size within five years.

Munro says there are three main causes responsible for the abnormal growth in demand. The first of these is a change of lifestyle. “The top end of the market is growing as

consumers are developing an appetite for the advantages of gas. These are driven by electricity supply interruptions as well as lifestyle choices associated with the convenience, efficiency and immediacy of gas,” explains Munro.

The second cause in the growth of demand for LPG is the ongoing grid electricity shortages, says Munro. “Because Eskom is not able to provide the security of energy supply, South Africans are finding alternative sources of energy to fulfill the basic needs of cooking and warmth, especially in the winter months,” he says.Generators offer an alternative source of power to reliance on the grid, but Munro points out that the majority of South Africans cannot afford the expense of a generator.

The final cause in the increased use of gas, and possibly the most significant, is government’s drive to make LPG an essential energy source for low-income households which currently use paraffin as a fuel source for cooking and heating.

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2007

Product Volumes in millions of Litres Q1 Q2 Q3 Q4

PETROL 2878 2778    

DIESEL 2316 2314    

JET FUEL 615 575    

ILLUM PARAFFIN 155 187    

FUEL OIL 104 113    

BITUMEN 92 90    

LPG 153 145    

SUM OF ABOVE 6313 6202    

“The essential energy source drive by government has the potential to add six-million consumers to the number of gas users, a substantial increase in the number of people currently making use of LPG as an energy source,” comments Munro. He says, based on the number of cylinders in the market at present, that the current number of users is about 2,5-million.

However, this extraordinary growth in demand, combined with supply constraints, has resulted in shortages of LPG over the past two winters.Munro says that several factors are creating a shortage of supply. Munro explains that Afrox, which is the largest supplier of LPG in South Africa, sources its product from the oil refiners that have limited supply capacity. (Refer to “Distribution Chain” on page 8). As a by-product of the oil refining process, there is a finite supply of LPG, which strictly corresponds with the quantity of oil refined.

“Without further significant investment in new refining plants we shall have to import, a path which Afrox is following in cooperation with the refiners and the Department of Minerals and Energy,” explains Munro.

He adds that in June this year, the company commissioned a 3 600-t storage facility in Richards Bay for imported product as part of a plan to alleviate some of the effects of current shortages.

While gas consumption is high in Europe, and growing in countries like Botswana, Sri Lanka and China, growth in SA hasn't been as fast as government would wish. But the reason may not be related to the cost of gas alone.

Gas appliances, such as stoves and heaters, are expensive; gas cannot be sold in small quantities, as paraffin can; and the industry itself is constrained by shortages of supply.

Despite the clean-burning usefulness and versatility of LPG, and the high demand for energy solutions in South Africa, LPG is not widely used in South Africa. Producer companies such as Afrox, Easigas, BP, TFE Tepco and Exel are of the view that LPG is capital intensive and requires investment in bulk tankers, bulk storage facilities, filling plants, scales, cylinders, cylinder delivery vehicles and installation on customer’s premises. This high level of investment must be weighed against the elasticity of the local LPG market. As the price of LPG fluctuates in relation to international oil prices, so the market changes. With an increase in the international price of LPG, domestic gas consumption decreases as consumers move down the energy chain towards IP, coal and fuel wood. However as income increases, domestic consumption move up the energy chain. In order to create constant demand for LPG, this sensitivity to international oil prices must be taken into account.

4. LPG PricingThe “Promotion of Access to basic energy for poor households” dated 21 Sept 2007 (Annexure B) strongly recommends that government should start considering to regulate the retail price of LPG as it is extremely expensive for end users.

In terms of this White Paper on Energy, whilst the government believes that competitive market forces should determine prices, it is also of the view that as long as price control is applied, the import parity pricing approach should be retained. Government has also stated that any move away from price control will occur in a phased process, initially removing control of industry margins, at wholesale and retail level and thereafter allowing price determined on a competitive and commercial basis.

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In South Africa and other countries, a price differential is often used to promote the use of certain products. The reasons for wishing to promote use of certain liquid fuels are usually to achieve another objective, such as the use of more efficient or cleaner fuels. In addressing pricing issues concerning LPG, consideration must be given as to how pricing policies will provide an opportunity to influence the fuel mix in order to support economic activities, constrain leisure activities, meet basic needs and address poverty alleviation. Pricing of LPG can be used positively to promote an economically and environmentally sustainable use of energy sources.

A huge problem to consider is that of the cost of LPG cylinders, and the rules that relate to cylinders in the South African market. Although much LPG is supplied in bulk, a significant portion of the market is supplied in producer branded cylinders. The ownership of all except the smallest of cylinders (6kgs and less) never passes from the producer company to the user of the cylinder. Rather, a deposit is paid for the use of the cylinder to the producer company. This deposit is passed on the next user down the supply chain. This significantly affects the price of LPG, particularly for low income, new entrants to the market. As most cylinders remain in circulation, it is not clear where the deposits all collect, and what the advantages and disadvantages are of the current system. Part of the reason for this deposit system is that an LPG cylinder may only be filled from the same company's larger cylinders. The rationale behind this rule appears to be that of safety and responsibility. For example, if a cylinder explodes, the source of that cylinder will be held responsible. If this concern is able to be addressed differently, the affect of the cost of the cylinder on the price and the market may be more fully considered.

Also, producers and distributors do not assist aspirant dealers to learn about the profitable running of a gas business. This results in the SME dealers competing in the only way they know best - price war. Therefore, while the retail price of LPG and cylinders have increased by about 30 % in the last two years, SME dealer's claim that their profit margins have shrunk. The challenges faced by BEE companies are the ability to import, store and distribute LPGas. Most BEE companies in this industry are either installers or small distributors with no containers or distribution channels of their own.

They are totally dependent on the big four - BP, Easigas, Afrox and Totalgaz for their LPGas. Lack of regulation of LPGas, according to the Mail & Guardian of 2 June 2006 resulted in a significant increase in the price of the product. During the LPGas roll-out in the Western Cape the small BEE distributors found themselves without LP Gas because the local supply was already committed, so they were not able to benefit from the LPGas roll-out.

5. Opportunities in the LPG marketA National Gas Infrastructure Development Plan (Annexure C) has been drafted to provide the government with a blueprint for the development of an infrastructure for future gas market developments. It is the DME's intention to coordinate development on the east and west coast of South Africa via this plan.

5.1 Extract from the Plan:

If one looks at Sasol’s success at penetrating a competitive market, the projection of trebling (3x as much) gas consumption is not unrealistic. Market research indicates that the otential demand outstrips the available proven resources. This is good news for the upstream and gas infrastructure investors.

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Projected cumulative demand (150MGJ p.a) for RSA 'eastern' market

Projected cumulative demand (220 MGJ p.a) for RSA 'western' market

The minimum gas demand for South Africa is estimated at 240 MGJ p.a. and the projected cumulative demand is 370MGJ p.a., indicating significant opportunities to grow the market.

There are a number of pipelines to be built in terms of the anticipated market developments. Essentially the developments represent 4 main phases, although within each phase, there may be a number of sub-phases:• Phase 1 = the Mozambique/South Africa Transmission Pipeline project.• Phase 2 = the Western Cape Transmission Pipeline• Phase 3 = the Northern Cape to Gauteng transmission Pipeline• Phase 4 = the coastal transmission pipeline

Once these phases are complete, there will be a fully integrated network linking the major economic centers with upstream supplies of gas enabling one to transport gas from any inlet flange in the system to any outlet flange where there is a market.

Government framework to facilitate the development

The South African Government is committed to the establishment of an appropriate framework to facilitate the development of a competitive gas industry.A number of tools are at Government’s disposal to promote the gas industry in terms of a stable regulatory environment and investor friendly fiscal regime. The challenge is to use these tools in a

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transparent manner that protects consumers from abuse, whilst assuring investors they will receive a fair and reasonable return.Due to the inflexible nature of pipeline infrastructure, the critical issues in regulating the gas industry are:

• To promote integration of closed networks giving alternative access to markets from different gas supplies

• Third party access, to ensure that all suppliers have equal access to markets• Non-discriminatory tariffs to prevent monopolisation of the pipelines• Economic regulation of the market to stimulate gas-on-gas competition.• Thus, it can be seen that regulation in the industry must manage the internal dynamics of

the gas sector in the broader context of energy regulation in general.

Investment toolsThe South African Government has introduced additional depreciation allowances for permanent structures, as outlined in the Minister of Finance's February 2000 budget speech, to encourage investment in strategic infrastructure projects:

a. Depreciation at 10% p.a for oil and gas pipelines over 10 years (Section 12(d) of the Income Tax Act),

b. Depreciation at 5% p.a electricity and telephone transmission lines and railway lines over 20 years (Section. 12(d) of the Income Tax Act)

c. Depreciation at 20% p.a of power plant (by virtue of the fact that it is a facility for use in a manufacturing process) over 5 years (Section. 12(c) of the Income Tax Act). The proviso is that for dispensation under Section 12(d) i.e. (a) & (b) above can only be granted if the asset forms part of the core business ie the applicant owns the asset as part of its business.

d. Dispensation under Section 12(c) can be granted to a third party such as a bank financing a power plant etc.

b) In specific instances there are additional investment incentives such as the promulgation of industrial development zones (IDZ’s) which will have a tailored package of fiscal related tools, such as VAT exemption for production that is not entering the domestic market e.g. imported inputs for a production platform for export to the global market.

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Note 1

LPG market set to double in five years

By: Shannon O’Donnell

Published: 31 Aug 07 - 0:00

Gas and welding company Afrox tells Engineering News in an exclusive interview that the size of the liquid petroleum gas (LPG) market in South Africa is growing at between 8% and 12% a year. Afrox GM for LPG Kevin Munro says the industry is expected to continue to expand and has the potential of effectively doubling its size within five years.

Munro says there are three main causes responsible for the abnormal growth in demand. 18

The first of these is a change of lifestyle. “The top end of the market is growing as consumers are developing an appetite for the advantages of gas. These are driven by electricity supply interruptions as well as lifestyle choices associated with the convenience, efficiency and immediacy of gas,” explains Munro.

The second cause in the growth of demand for LPG is the ongoing grid electricity shortages, says Munro. “Because Eskom is not able to provide the security of energy supply, South Africans are finding alternative sources of energy to fulfil the basic needs of cooking and warmth, especially in the winter months,” he says.

Generators offer an alternative source of power to reliance on the grid, but Munro points out that the majority of South Africans cannot afford the expense of a generator.

The final cause in the increased use of gas, and possibly the most significant, is government’s drive to make LPG an essential energy source for low-income households which currently use paraffin as a fuel source for cooking and heating.

“The essential energy source drive by government has the potential to add six-million consumers to the number of gas users, a substantial increase in the number of people currently making use of LPG as an energy source,” comments Munro. He says, based on the number of cylinders in the market at present, that the current number of users is about 2,5-million.

However, this extraordinary growth in demand, combined with supply constraints, has resulted in shortages of LPG over the past two winters.

Munro says that several factors are creating a shortage of supply. “This is despite the company’s efforts to import product to alleviate the shortages experienced this winter, and to prepare for further demand growth ahead of winter 2008 and beyond,” he says

Munro explains that Afrox, which is the largest supplier of LPG in South Africa, sources its product from the oil refiners that have limited supply capacity. “As a by-product of the oil refining process, there is a finite supply of LPG, which strictly corresponds with the quantity of oil refined,” he says.

“Without further significant investment in new refining plants we shall have to import, a path which Afrox is following in cooperation with the refiners and the Department of Minerals and Energy,” explains Munro.

He adds that in June this year, the company commissioned a 3 600-t storage facility in Richards Bay for imported product as part of a plan to alleviate some of the effects of current shortages.

However, despite these initiatives, other vari- ables continue to affect supply. “Among these

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challenges is transport logistics, where rail infrastructure, in particular is not geared to the needs of LPG transportation, often resulting in erratic and unpredictable inbound receipt of product to the Afrox branch facilities,” laments Munro.

Nevertheless, demand will continue to grow apace, with new customers entering the market across the spectrum.

Edited by: Laura Tyrer

Note 3

ARTICLE FROM ENGINEERING NEWS (http://www.engineeringnews.co.za

Association partners DME to ensure adequate gas supply By: Dennis Ndaba

Published: 1 Sep 06 - 0:00

The demand for gas has increased significantly, although the rising popularity of liquefied petroleum gas (LPG) has been marred by recent shortages, blamed on refinery shutdowns and a cold and early winter experienced in many parts of the country.

“With gas growing in popularity, we cannot afford for this to happen,” says LPG Safety Association of Southern Africa (LPGSASA) communications manager Kevin Robertson.

“We are working closely with the Department of Minerals and Energy and other stakeholders to see what can be done to prevent this from happening again.” One of the challenges identified by the association is to ensure that there is sufficient LPG supply, particularly in light of expected continued growth in demand.

“Alternative arrangements are being made to address meetng these demands,” Robertson adds.

The LPGSASA is a safety organisation that represents many com-panies, which are involved in the distribution, retailing and installation of LPG and gas appliances.

The association works very closely with the various fire departments in the control and approval of all LPG sites, as well as with the South African Bureau of Standards and with all standards, codes and practices as they pertain to the industry.

“We also work closely with the Department of Labour in ensuring these standards are met and maintained, while offering training to our members to help them to conform to the standards.” As a safety measure, all LPG installations throughout the country have to be carried out by registered installers and the association is working to educate communities on how to use LPG safely. Robertson notes that the increased demand has also led to a shortage of skilled workers.

“There is a requirement for gas installers in all facets of the industry. “The growth of LPG in the

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domestic area, particularly in rural areas, will create many opportunities in the gas industry.

“If people are moving away from electricity to an alternative fuel, the alternative fuel must be efficient, safe, and versatile.” Interestingly, international trends indicate that the fuel of choice for cooking is gas.

“It’s clear that a move from electricity to LPG is a step forward rather than backward,” Robertson affirms.

Beyond Africa As this is a growing industry, the association is concerned about international suppliers coming into the market with cheaper, and possibly substandard, products.

As a result, it has developed a ‘Safe Appliance’ scheme to prevent unsafe gas appliances and equipment from entering the market.

The association believes that LPG will continue to be popular, as it is the right fuel of choice to be used in all areas. “We will continue to ensure and encourage people to use LPG properly for the whole indus- try to be safe,” concludes Robert-son.

The association has helped Botswana to establish its own safety association and has done work in Lesotho, Swaziland and Namibia.

Edited by: Dennis Ndaba

Coupon No.: MW0091972

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